“He who digs a hole for another, may fall in himself”: China’s hidden economic problems

Posted on | augustus 11, 2011 | No Comments

Following the downgrade by Standard and Poors of US sovereign debt from the gold standard AAA to AA+ the Chinese government lambasted the United States for its ‘addiction to debt’ and called on the United States to implement more responsible policies to bring its deficit problems under control. At the same the governor of China’s Central Bank restated that the Chinese government would continue to look to diversify its investments out of US treasuries. China’s words are of little surprise, as the single largest foreign holder of US treasury bills and securities, estimated at in excess of $1.2 trillion worth, the Chinese are clearly anxious about the value of their investments. Yet again such statements coupled with the psychological blow to the US of losing its top-rated debt rating prompted renewed soul-searching about American decline and the seemingly inexorable rise of China. And yet such talk misses a number of important considerations.

1) The Undervaluation of the Chinese Remimbi (Yuan)

How and why has China accumulated such enormous stocks of US securities? It is widely accepted among economists worldwide that China’s currency has been deliberately kept undervalued by the Chinese government for years. The rationale behind this decision is multi-faceted but put simply goes something like this. Keeping its currency low boosts the export sector of the Chinese economy and it is this sector that has been largely responsible for the dynamic growth of the Chinese economy over the past three decades. Basically, if 1 Dollar buys 7 Yuan, and a exporter sells a Chinese Shirt for 10 dollars – he pockets 70 yuan. But if one Dollar was worth only 5 Yuans, the exporter would only be able to pocket 50 yuans. Conversely by keeping its currency undervalued imports from other countries (i.e. US exports) are kept more expensive. This has naturally resulted in a massive trade surplus.

In a free currency market China’s surplus would indicate an excess demand for Yuan by foreign buyers of Chinese goods which would lead the Chinese currency to appreciate in value against for example the US $ until the surplus was eliminated. However because China manipulates its currency the government itself prints billions of Yuan in order to buy US dollars to boost international demand for the dollar and keep it artificially high. One way of doing this is to buy US treasuries since the products a) are considered safe investments and b) deliver a fixed rate of return (interest) to the Chinese government. In practice what this means is that for years the recycling of trillions of dollars by the Chinese government has effectively meant that poor Chinese peasants have been subsidizing overconsumption by the US government and US consumers!

It has also had inflationary consequences for the Chinese government contributing to a dangerous property bubble that potentially could be as catastrophic for the Chinese economy as the collapse of the US housing market in 2007-08. In 2010 construction accounted for 13 per cent of the Chinese economy, twice the level of the 1990s. Beijing is one of the most expensive real estate markets in the world relative to the average income of its population. Between 2006-2011 the price for an average apartment in Beijing in rose from $100,000 to $250,000, or put another way from the equivalent of 32 years disposable income for the average resident to 57 years. During this property boom China’s middle classes have bought record numbers of second homes, simply as speculative investments, and are reluctant to sell, or indeed rent. The opacity of the banking system means economists have no idea how much of the borrowing extended was easy credit, but already prices in Beijing and Shanghai have begun to fall.

2) China’s own debt mountain

The other great quandary is just how big is China’s own national debt. Again the problem is simply that economists cannot trust the official government figures because of the lack of transparency in national statistics in China and indeed the deliberate manipulation of those figures by the Communist government. Officially China’s budget deficit is a little over 3 per cent of GDP compared to the US figure of 12.3 per cent. Its official national debt is 10.3 trillion yuan which equals $1.5 trillion or 17-20% of its GDP (depending on estimates). America’s current $14 trillion national debt is equivalent to about 72 per cent of the national income. So no problem then?

“A paper tiger cannot bear close scrutiny”

Well not quite… following a report from China’s state auditor that local governments had run up 10.7 trillion yuan of debt Moody’s has calculated that the local government debt burden in China could be 3.5 trillion yuan ($500 bn) higher than previously estimated. Furthermore Beijing based research firm Dragonomics argues that because of local government debts and the lack of separation of the country’s Central Bank from the government the figure could be much higher. How much higher? Another 23 trillion higher! At this level China’s national debt would be equivalent to 89 per cent of GDP or in other words worse than the United States.

The problem is we simply don’t know how big China’s debt is, but increasingly analysts are starting to examine Chinese economic figures and statistics ever more closely. From ghost cities such as Ordos and Manzhouli, with the capacity for 5 million inhabitants but populations of just 150,000, to prices in some Shanghai and Beijing bars in excess of London or Paris the Chinese economy just doesn’t seem to make sense. As a result the bears are starting to gather and fund managers are getting more and more concerned that the Chinese economy might be built on a house of cards.

AUTHOR: Dr. Jason Abbott
URL: http://profjabbott.blogspot.com
E-MAIL: jason.abbott [at] louisville.edu


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